LONDON, July 27 (Reuters) - Spanish and Italian yields fellon Friday on expectations the European Central Bank will act totackle the two countries' inflated borrowing costs, but therally in peripheral debt risked stalling without quick follow-upsteps.

A French newspaper said the ECB and euro zone governmentswere preparing co-ordinated action to cut Spanish and Italianborrowing costs.

This followed ECB chief Mario Draghi's pledge on Thursdaythat the bank would do whatever it took within its mandate tosafeguard the single currency, cooling demand for German Bunds,which have been one of the main safe havens for investorsseeking to preserve cash.

Spanish yields fell 21 basis points to 6.75 percent , pulling further away from the euro-era peak of7.78 percent hit earlier this week as fears grew Madrid wouldneed a full state bailout in addition to an agreed bank rescue.

Equivalent Italian yields were down 14 bps at 5.89 percent, falling below 6 percent for the first time in aweek.

Analysts and traders said a sustained fall in Spanish yieldsbelow the 7 percent mark beyond which borrowing costs couldbecome prohibitive depended on quick action from the ECB.

"They (the ECB) obviously want to support the market butthey run the risk of causing massive disappointment if theydon't follow through with something," said Charles Diebel, headof rates strategy at Lloyds Bank.

"Spanish yields can go down about 100 basis points if wereally think that something big is coming. But for now the juryis out."

GERMAN STANCE KEY

Ireland added to the cautiously upbeat tone across the eurozone periphery with a sale of new long-term government debt onThursday, the first since it took an EU/IMF bailout in 2010.

The ECB, which meets next week, has bought Italian andSpanish yields in the secondary market before but mothballed theprogramme this year as EU policymakers hammered out new measuresto fight the crisis.

"The fact that the ECB has made these comments should instilmoderate confidence that at least for the short run Italian andSpanish bonds are not blowing out. That may stabiilise themarket," said Riccardo Barbieri, a strategist at Mizuho.

"Levels around the 6-7 percent for Italian and Spanish bondyields should be a cap for now."

Many market participants were, however, worried that apushback by Germany's Bundesbank could curtail the ECB's abilityto act boldly.

The programme has been mothballed for months now as EUofficials tried to hammer out new measures to tackle the crisis.

"It looks like there's an elevated chance there's somethingin the works but it could be disappointing given the Germanstance," a trader said.

Bund futures were last 21 ticks down on the day at143.80, having fluctuated in and out of negative territory onthe comments from German and euro zone officials.